Eleven from the top

Fund managers at Morningstar confab offer stock picks

CHICAGO (CBS.MW) -- Only about 70 people showed up at Morningstar's first investor conference 14 years ago. This year, 1,300 were on hand for the affair, all seeking wisdom from some of the nation's top mutual fund managers.

"I think we have an oddity for these times: An investor conference whose attendance is up," said Don Phillips, managing director of the Chicago-based financial services firm.

One such conference, sponsored by the Los Angeles Times, drew 10,000 participants in 2000 but just 5,000 a year later. This year, Phillips said, it isn't even being held.

"I thought we were becoming a nation of investors. But instead what I see now is that we've become a nation that likes a bull market," Phillips said.

Those who continue to attend the Morningstar conferences are rewarded with the inside scoop on what managers are thinking and what stocks they have recently added to their portfolios -- or grown weary of in their mutual fund.

Here are 11 stocks that were being talked up at this year's event:

Borders and Zale Corp.

Kent Gasaway made his Buffalo Small Cap Fund
BUFSX, +0.25%
so popular that he had to close it to new investors earlier this year to keep it from growing to cumbersome to fit his investing style.

Gasaway and his colleagues have identified 18 long-term trends they believe will drive society, and hence the markets, in years to come.

"These trends take place regardless of what happens in the economy," he said. "They are not fads or themes."

One of those trends: Demographics. The U.S. population is aging and that leads to stock opportunity, he said. His two picks, Borders Group
BGP, -6.38%
and Zale Corp.
ZLC, +0.84%
come out of the same trend.

"As people age, they tend to read more. And they tend to buy more jewelry as they get older," he said.

Carmax

Eric Ende, manager of the FPA Perennial Fund
FPPFX, +0.30%
looks for small-cap stocks where the business has a high return. His fund only holds about 35 stocks.

"I emphasize my best ideas. I want to know what I own," he says.

Used car retailer Carmax,
KMX, +1.18%
a spin-off from Circuit City, is a $2 billion company that is in a good position to grow, Ende said.

"They have really invented a new way of selling used cars. They overexpanded a little bit, and that slowed them down. But their only competitor - AutoNation -- is gone and they are ready to capitalize," he said.

Chico's FAS Inc.

James Harmon manages three funds for Fidelity: The Small Cap Independence Fund
FDSCX, +0.18%
Small Cap Retirement Fund
FSCRX, +0.00%
and Small Cap America Fund. He calls his picks an "eclectic mix."

Chico's
CHS, +1.00%
is one of the few retailers he likes. He thinks the women's apparel purveyor is undervalued and doesn't understand why.

"Same-store sales on average have been growing about 20 percent per year over the last five to six years," he said. "People are only starting to understand just how good some of these companies are."

Citigroup

Karen Reidy has to look company executives in the eye to determine if she is comfortable handing them a dollar out of her own wallet. If not, she's not handing over her fund-holders dough.

Reidy is a Janus executive vice president who oversees six funds, including the Janus Balanced Fund
JABAX, +0.30%
and the Core Equity Fund
JAEIX, +0.00%
And one of those core picks is Citigroup
C, -1.30%

"The power of the company is its massive distribution reach and the cadre of products it can push through that network," Reidy said. "It's global and it can take the massive capital it generates and further strengthen its reach and its product lines."

The stock is well off its 52-week high. But Reidy said that its valuation at 14 times earnings and 2.4 times book value, coupled with the $2.4 billion in cash it generates a month, "are fantastic reasons to own."

Commonwealth Industries

It pays to keep an open mind on companies, even if things seem to be falling all around them, Warren Isabelle says.

Isabelle, who runs the ICM/Isabelle Small Cap Value Fund and the IDEX Isabelle Small Cap Value fund, listens to thousands of company presentations a year from firms seeking capital.

Commonwealth Industries
CMIN
was one presentation that might have been easy to turn a deaf ear to since the aluminum manufacturer had been suffering through a prolonged period of slackening demand for its sheets of metal that go into products as diverse as appliances and trucks.

"But they had been doing everything right in the face of that poor demand," Isabelle said. "And now they are beginning to see an uptick ... they are well positioned to take advantage."

"I met Paul Walsh and knew he was due to become CEO (in September 2000.) He ran Pillsbury for eight years before that and what's the first thing he does as CEO? Sells Pillsbury. That's the opposite of empire building," Davis said.

Instead, Walsh turned around and bought Seagram's.

"Now his market share is twice as large as his nearest competitor. At a 15 multiple (to earnings) the stock price is no giveaway," Davis admits. "But you have no idea how far a great manager can take a business."

Lexicon Genetics

When researching and investing in extremely small companies, you have to be mindful of the role one or two key people can play in those organizations.

"Our micro-cap companies have less than a $400 million market cap. Those kind of companies can be fragile," said W. Whitney George, senior portfolio manager of Royce & Associates and manger of the Royce Micro-Cap Fund.
RYOTX, +0.08%

"The company itself may be dominated by one individual and may have only one or two major customers. You can't imagine all the strange and varied things that can happen to companies in those situations," he said.

But that doesn't mean you can't pick winners. George said thinks he has one in Lexicon Genetics.
LEXG, -2.31%
The biotech company deciphers gene function, hoping to translate it into therapeutic breakthroughs.

"It's a 4 1/2-dollar stock with $3 cash on the balance sheet," George said. That mitigates a lot of the risk, he figures.

J.C. Penney

William Nygren tries not to get caught up in daily grind of the market. The news of the moment can obscure your investment goals pretty fast if you do, the manager of the Oakmark
OAKMX, -0.15%
and Oakmark Select
OAKLX, -0.53%
funds believes.

"We take a long-term time frame. When we make an investment, we assume we'll own it for five years," Nygren said. "The five-week or five-month outlook is very clouded anyway."

In the case of department store owner J.C. Penney
JCP, -0.64%
skewed news earlier in the year might have caused investors to miss an opportunity.

"Management said that it expected to earn $4 to $5 per share within four to five years. But the next day, the only news (on First Call) was of the 60 cents they expected to earn that year," Nygren said. "The analysts said that made the stock 'fully valued.' But not for the long term."

Nuco2

When the companies you invest in have a micro-cap market value of $375 million on average, you have to exercise extra diligence -- and be willing to accept greater risks.

But Bill Wolfenden, manager of the RS Smaller Company Growth Fund
RSSGX
sees plenty of places where the risk may be worth it.

"The volatility of this asset class is pretty heavy. We put a lot of emphasis on the management teams when we look at companies," he said.

One he likes is Nuco2
NUCO
a small company that services the carbon-dioxide canisters that, among other things, keep the fizz in the sodas from your favorite restaurant.

"It's a service to the hospitality industry. Instead of hauling around the huge canisters of CO2, they come and refill your supply monthly," he said. "There is stable revenue and it's growing quite rapidly."

PEC Solutions Inc.

The federal government bureaucracy can be awfully fouled up. But that can create opportunities for the right companies, says Kevin Landis, chief investment officer for Firsthand Funds.
TVFQXTLFQXTIFQX

"Government spending can help tech companies in two ways," he said. "There's a lot of tech involved in getting the bad guys. But there is also opportunity in information technology outsourcing, consulting firms that can help the government tackle information flow and tie systems together."

PEC Solutions
PECS
is just such a company. One of its biggest jobs for the government so far: Integrating the national fingerprint database into the Immigration and Naturalization Service's operations.

"The INS held a guy for 48 hours and had to let him go. It took two weeks to match his prints," Landis said. "The guy was a wanted murderer, who killed again before they got him."

Investment tip

The smaller the companies you want to invest in, the better off you are in a mutual fund that can spread the risk of those small investments around.

"The micro-cap area, especially, is well suited to owing a diversified portfolio for all the risk reasons you can think about," said Wolfenden, whose fund holds 90 to 95 stocks.

"It's best to look for unleveraged companies with a three- to five-year horizon," added George, whose fund as 180 names in it. "We look for stocks that we think will double or triple in that time."

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